Here’s an unhappy early Easter thought: The financial crisis is about to be reborn in Europe.
Bondholders are bracing as Greece, Portugal and Ireland come to grips with huge debts and sinking economic prospects. Rumors have a Greek restructuring happening as soon as this weekend, though analysts at Goldman Sachs say next year is more likely.
Is the euro a basket case?
Not that you’d know the difference to look at the market. The annual cost of insuring $10 million of Greek debt soared past $1.4 million this week, and the yield on 10-year Greek bonds hit an eye-watering 15%. Credit spreads hit new highs in Ireland and Portugal too.
Investor flight from Greece, Ireland and Portugal has the makings of an existential problem for the euro zone. The European Union has spent the past year bailing out weak states and their too-big-to-succeed banks, without addressing the productivity problems that laid the weaker states low in the first place.
Yet the euro, thanks to the inflation-squashing vigor of the European Central Bank, is now trading within 10% of the all-time high it hit against the dollar in 2008, just before the global economy came apart at the seams. The higher the euro goes, the more stress on laboring European economies. How long can this go on?
In an ugly new twist on Keynes’ aphorism, it is starting to look like the market can stay irrational longer than Europe’s weaker states – or their banks — can stay solvent. When investors finally catch on, the fall could be brutal.
“We’re peering over the precipice right now,” says Scott Minerd, chief investment officer at Guggenheim Partners. He is betting the euro will fall from a recent $1.46 (see chart, right) toward parity with the dollar or even beyond, as investors finally divine the extent of Europe’s problems: “There is just no way out when you start to add up all the numbers.”
The unhappy math starts with the banks. In a replay of the subprime crisis here, the banks in Europe are politically powerful — but financially weak, largely opaque and highly exposed to the worst case scenario, in this case a sovereign default.
The three weak European states account for just 5% of annual European Union economic output. But EU banks hold $147 billion of Greek sovereign bonds and $115 billion of Irish and Portuguese debt – including $108 billion of bonds held by EU banks outside those countries.
And if anything,